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Bank Debt Regulations Implications for Bank Capital and Bond Risk

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  • Stig Helberg

    () (Department of Economics, Norwegian University of Science and Technology)

  • Snorre Lindset

    () (Department of Economics, Norwegian University of Science and Technology)

Abstract

We use a structural model of default risk to study how optimal bank capital and bond risk are influenced by deposit insurance, implicit guarantees, depositor preference, asset encumbrance, and bail-in resolution frameworks. We find that these features of bank financing, in addition to having an immediate impact on bond debt risk, also change optimal bank capital, countering the first-order effect on bond debt risk. Bondholders' risk is thereby not materially affected, but shareholder value and public sector value are. A gap between optimal capital and required capital represents a cost to shareholders, and increases the risk of regulatory arbitrage. Enhancing capital requirements, and at the same time adopting bank debt regulations that reduce the optimal capital, is to gain some and lose some in terms of financial stability. Based on a small sample of European banks, we find support for the central model predictions.

Suggested Citation

  • Stig Helberg & Snorre Lindset, 2013. "Bank Debt Regulations Implications for Bank Capital and Bond Risk," Working Paper Series 14813, Department of Economics, Norwegian University of Science and Technology.
  • Handle: RePEc:nst:samfok:14813
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    File URL: http://www.svt.ntnu.no/iso/WP/2013/10_bankdebtreg_SH_SL.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Bank debt regulations; optimal bank capital; bond risk.;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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